Equity Shares: Definition, Features, Types, Merits and Demerits
Purchasing company stocks or equity is a popular investment strategy among individuals due to the considerable amount of returns it promises to offer. When an investor purchases equity shares, he/she/they becomes a fractional owner of the company. Investing in common stocks ususally bestows upon the investor the right to vote in the annual general meetings of the firm and participate in its decision-making activities.
Equity shares are primarily distributed to retail and institutional investors as a medium to mobilise capital for the expansion of the issuer’s business. Business organisations source the majority of their capital after getting listed on stock exchanges through this mechanism.
Let us understand how equity shares work, their types, benefits and risks.
What Are Equity Shares?
Equity shares represent ownership and act as long-term financing options for organisations looking to raise capital. Investors become fractional owners of the companies which they invest in on account of this. Additionally, these member shareholders possess voting rights, share profits and claim assets in the organisation.
Equity shares are also known as ordinary shares, common shares or common stock, as they offer an investment opportunity to the general public. They are non-redeemable in nature, and an investor can only redeem them when the company gets closed. The value of equity shares can be expressed in various terms such as par value, book value, face value and so on.
What Are the Features of Equity Shares or Equity Share Capital?
The primary features of equity shares or equity share capital are as follows:
- Permanent in nature: Equity shares issued by a company are non-redeemable and permanent in nature. They can be redeemed only when the company decides to close its business.
- Potentially higher returns: Although equity shares are volatile and possess high-risk factors, the returns they offer can be very high. If an investor has the potential to accommodate more significant risks, he/she can earn a massive corpus from equity investment. This outcome is however conditional on how the issuer mobilised funds and generated profit.
- Transferable and offers dividend pay-out: The ownership of an equity share is transferable between investors, and in addition to earning a return on account of capital appreciation, equity investors can also benefit from dividends paid to them by equity issuers. This is however subject to the issuer’s decision with respect to distribution of company’s funds. It is a common practice for companies to not indulge in dividend payouts at times of financial distress.
- Management and voting rights: Equity shareholders are eligible for voting rights and can indirectly take part at a degree proportional to their stake in the company’s management. Equity shareholders in contrast to other providers of capital might also have access to excess profits generated by the issuer.
What Are the Different Types of Equity Shares?
The different types of equity shares are as follows:
- Ordinary shares or issued shares
Ordinary shares are issued by a company with a motive to generate capital that can meet long-term expenses incurred by their business. They offer associated benefits to an investor like the right to participate in management meetings and other operations. Investors holding a majority of such shares gain substantial voting rights and can thereby exercise significant control over various aspects of a company’s operations.
- Preference equity shares
Preference equity shares include a payment guarantee of cumulative dividends paid before distribution of returns (if any) to the ordinary shareholders. Preference shareholders have little to no voting rights. They can gain from stipulated profits, including bonus returns, if they have participating capacity. If these preference equity shares are classified as non-participating, the shareholders cannot avail of such benefits.
- Bonus shares
Bonus shares are issued to the investors in place of cash dividend when a business generates profit and/or splits their stocks. These shares do not increase the total market capitalisation value of a company.
- Rights shares
A company offers rights shares to existing stockholders at a discounted price. This enables investors to grow their stake and preserve proprietary rights. Organisation usually offers rights shares for a limited time until the underlying extraordinary financial requirements are adequately met.
- Sweat equity shares
Sweat equity shares are allocated to outstanding executives or workers of a business organisation. These are given as a reward for excellent work and may also provide property rights of an organisation to the entitled investors.
- Authorised shares
Authorised shares is the term used to define the maximum number of shares an organisation can issue. The value of these shares can change at any time.
- Subscribed shares
Subscribed share is the portion of the issued share capital that an investor accepts and agrees upon investing.
- Paid up shares
Paid up shares are a section of the subscribed share capital that an investor provides. This is the money that an organisation actually invests in the company’s operation.
What Are the Merits Involved in Purchasing Equity Shares?
The merits or advantages involved in purchasing equity shares are as follows:
- Potential to earn a high reward
Although equity shares entails an array of high risk factors, they usually come with a greater return potential. In addition to earning via capital appreciation on account of rise in share price, when a company earns profit, its investors might get cash or kind dividends pay-outs.
- Provides creditworthiness
When an investor owns equity shares of a firm, it can act as collateral on various loans as per requirement. These shares reflect the creditworthiness of a firm and can help the shareholder get quick approval of loans.
- Investment is highly liquid
A crucial factor which an investor should take into account before investing in any financial instrument is liquidity. This liquidity is the ease with which an investor can convert an investment into cash.
In this regard, equity shares are highly liquid and can easily be sold in the capital market. Thus, in case of an emergency, an investor can liquidate equity shares with greater ease.
- Diversification of investment portfolio
Diversification offers exposure to equities of various sectors and helps create a balanced portfolio for the investor in terms of risk and return. Investors can diversify their portfolios by investing across equities from various sectors or industries.
- An easy and efficient way of investment
Any individual can easily invest in the equity market by availing the services of a stockbroker. All an investor requires to invest in equity of any company of his/her choice is a Demat account. A Demat account enables an efficient and easy way of trading equity instruments .
What Are the Demerits of Buying Equity Shares?
The demerits or disadvantages which limit an investor from buying equity shares are as follows:
- If the company undergoes liquidation, equity investors are not entitled to get back their investment. The priority will be given to preference shareholders and creditors, and only after that equity shareholders will be paid.
- Share prices of listed companies might fluctuate due to a number of factors. Therefore, it becomes a risky investment and may not suit the appetite of conservative investors.
- The preference shareholders will receive priority in dividend payment.
- Investments in equity shares require a lot of planning and in depth knowledge about functioning of the respective industry and market as a whole. It may not be ideal for new and inexperienced investors.
What Is the Difference Between Equity Shares and Preference Shares?
The differences between equity shares and preference shares is discussed below:
|Parameters||Equity Shares||Preference Shares|
|Dividend Pay-out||Equity shareholders receive dividends after preference shareholders and when all liabilities are paid off. It is prudent to note that equity shareholders might not receive dividends if the company decides to plough back profits for capex.||Preference shareholders are given more priority and receive dividends before equity shareholders.|
|Rate of Dividend||The rate of dividend fluctuates for equity shareholders depending on the company’s profit and company’s willingness to distribute these profits.||The rate of dividend remains fixed for preference shareholders.|
|Voting Rights||Equity shares offer voting rights.||Preference shares usually do not offer any voting rights.|
|Role in Management||As equity shareholders enjoy voting rights, they can also participate in management decisions.||Preference shareholders are usually not allowed to participate in management decisions.|
|Redemption||It is transferable but not redeemable.||It is redeemable after a certain period of time.|
|Bonuses||Equity shareholders are granted bonuses against their current shareholdings.||Preference shareholders do not receive bonuses against their current shareholdings.|
|Capital Repayment||It is repaid when the company dissolves.||It is repaid or reimbursed before the equity shares.|
|Arrears of Dividend||Equity shareholders are not entitled to receive arrears of dividends.||Preference shareholders can avail of arrears of dividends in addition to the current year’s dividends i.e. preference dividends are cumulative in nature.|
Investing in the equity share market requires a lot of time and effort from the investor’s end. It is recommended never to make any investment decision without having complete knowledge of the fundamentals and finances of the company of choice. Once an investor gains enough experience and knowledge, he/she can build a considerable corpus through equity market investment.
Frequently Asked Questions
How to buy equity shares?
One can make an investment in the equity share using the following:
Demat Account: To hold the securities or shares in electronic form.
Trading Account: To buy or sell shares and place orders (Must be registered with a stock brokerage firm).
Linked Bank Account: To purchase equity shares via the stockbroker platform.
Investors can either purchase equity shares through an IPO, or they can purchase them through the secondary market after the company gets listed.
Who should invest in equity shares?
Anyone can begin investing in equity shares with a small or medium capital investment fund. Generally, if an investor has a high-risk appetite and long-term goal, it might be better to invest in equity funds as they offer enhanced security on account of diversification.
What is an alternative investment option to equity shares?
An alternative investment option to equity shares is debt securities which are considered to be less risky. However, the returns that these securities generate are smaller than equity shares, reducing the chances of generating substantial capital gains.
What is the difference between shares and equity shares?
The primary difference between shares and equity shares is that equity shares reflect ownership of a business entity. It cannot be traded freely in the market. On the contrary, a share is only a portion of equity measured in terms of value, number and percentage in that entity. These can be easily traded in the market through stock exchanges.